English Portfolio Management

Norwegian investments: Insights from the world’s largest fund

The world’s largest sovereign wealth (Norway) believes in relatively efficient markets and follows a passive approach with a 70:30 stock:bond index and little deviations.

The Norwegian government pension fund is the world’s largest sovereign wealth fund and has a significant share of the European and global listed equities (2.6% versus 1.5% 10 years ago). In addition, its government bond portfolio has invested in developed countries since its inception in 1996. Because of its global importance, its investment strategy deserves closer scrutiny by private investors.

The sovereign wealth fund manages Norway’s natural resources in a sustainable manner and invests primarily outside of Norway (only a small sub-fund invests in the country). Its objectives are twofold:

  1. It aims to avoid the so-called Dutch disease (revenue imbalance resulting from a sudden influx of natural resource wealth) in order to convert volatile oil revenues into a more stable source of revenue to support long-term public spending;
  2. It takes into account future generations by converting income from a non-renewable resource (oil) into a permanent capital maintenance scheme. In line with the expected real return, the fund transfers 3% of its value (3.9% exceptionally in 2020 due to COVID) to the government budget.

Norway’s investment beliefs are formally stated: they include the existence of well-functioning stock markets (relatively efficient markets) as well as the consideration of size constraints (the large size of the fund is seen as an obstacle to value creation through alternative investments or active management with only 4% delegated to external active managers compared to 10% ten years ago). Its size, however, allows for significant economies of scale. Norway is cost-conscious and emphasizes transparency and simplicity of approach. The fund does not favor private assets over different investment approaches, such as the Yale model or the Canadian model.

The fund also has a long time horizon, a limited need for immediate liquidity and no clearly defined liabilities (it is an asset allocator, not a liability matcher), which gives it considerable freedom in how it invests. Based on predefined criteria (avoidance of arms, tobacco and coal), certain industries are excluded from the investment horizon.

Its strategic benchmark is now a 70:30 stock:bond index. The 70% is allocated to global equities (represented by the FTSE Russell’s Global All-Cap Index – excluding Norway) and the remaining 30% to global bonds (represented by 70% government bonds [weighted by gross domestic product of all countries] and 30% corporate bonds [weighted by capitalization]). Similarly, country and sector deviations from benchmarks are small.

The exception to this diversification of the investment universe is alternative assets. The fund avoids investing in hedge funds and private equity funds (due to their lack of transparency and objectivity in valuations as well as doubts about alpha generation after deducting high management fees and inherent risk). The main diversification from bonds and equities is real estate, with an allocation close to 3% (two-thirds in unlisted investments and one-third in listed securities).

Application for private investors:

The fund considers that stock markets are relatively efficient and therefore offer limited opportunities for active management. The principles of transparency and clarity of governance, low management costs, high liquidity and high standards of ethical behavior may inspire individual investors to replicate a similar passive strategy. With its focus on costs, the Norwegian model leans toward passive investing with very low tracking error and near-market performance.

Despite the structural differences between the world’s largest sovereign wealth fund and an individual investor, this approach to managing long-term asset pools will remain a model for long-term investors, including smaller ones, as small and large investors should also avoid active management in their core portfolios. You will find here further key investment principles for private investors.

Source: The Norway Model in Perspective, Volume 47, Issue 5, 2021, David Chambers, Elroy Dimson, and Antti Ilmanen